of 23 /23
BASEL III PILLAR 3 DISCLOSURES December 31, 2013

BASEL III PILLAR 3 DISCLOSURES December 31, 2013 · Basel III Pillar 3 Disclosures December 31, 2013 3 Table 1. Scope of application ... Table 2/3. Capital Structure and Capital Adequacy

  • Author
    others

  • View
    4

  • Download
    0

Embed Size (px)

Text of BASEL III PILLAR 3 DISCLOSURES December 31, 2013 · Basel III Pillar 3 Disclosures December 31,...

  • BASEL III PILLAR 3 DISCLOSURES

    December 31, 2013

  • 2

    Table of Contents

  • HomEquity Bank

    Basel III Pillar 3 Disclosures December 31, 2013

    3

    Table 1. Scope of application

    HomEquity Bank (the Bank) is a federally regulated Schedule I bank, incorporated and domiciled in Canada. The Bank’s main business is to

    originate and administer reverse mortgages. The Bank also issues guaranteed investment certificates to fund its mortgage portfolio. The

    Bank is a wholly owned subsidiary of HOMEQ Corporation (HOMEQ), a private company. HOMEQ is wholly owned by Birch Hill Equity

    Partners Management Inc., which is the ultimate parent of the Bank. The Bank’s principal subsidiary is CHIP Mortgage Trust. All of the Bank’s

    subsidiaries are directly or indirectly wholly owned.

    Basis of preparation

    This document represents the Basel III Pillar 3 disclosure for the Bank. These disclosures are made pursuant to the Office of the

    Superintendent of Financial Institutions (OSFI) requirements, which are based on global standards established by the Bank of International

    Settlements, Basel Committee on Banking Supervision (BCBS).

    The amounts disclosed in this document are based on the Bank’s annual and interim consolidated financial statements, which reflect the

    financial position and results of operations of the Bank consolidated with the financial position and results of operations of its subsidiaries.

    The annual consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as

    issued by the International Accounting Standards Board (IASB), including the accounting requirements specified by the OSFI, and reflect,

    where necessary, management’s best estimates and judgments. This report is unaudited.

    Risk Management

    The Board of Directors (Board) has developed and approved a Capital Management Policy (CMP) in accordance with the Board-approved Risk

    Appetite Framework (RAF). The policy addresses minimum regulatory capital requirements as prescribed by regulators and internal capital

    targets as per the Board-approved RAF, which allows for the appropriate allocation of capital to meet the Bank’s strategic goals. The CMP

    dictates that capital be adequately maintained by the Bank.

    Adherence to the CMP ensures that the Bank has sufficient capital to maintain its operations based on current activities, expected future

    business developments and the possibility of various disruptive or adverse scenarios based on the Bank’s stress testing program. Such stress

    testing scenarios include periods of economic downturn and/or asset re-pricing. In addition, in accordance with the Bank’s annual strategic

    planning, a 3-year forecast is prepared and provides guidance as to the type and extent of capital that will be required over this period of

    time.

    The Bank’s Asset Liability Committee (ALCO) ensures adherence to the policy on at least a monthly basis and the Conduct Review and Risk

    Management Committee (CRRMC) of the Board ensures capital management in accordance with the Policy on at least a quarterly basis.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    4

    Table 1. Scope of application (continued)

    The Bank uses the annual Internal Capital Adequacy Assessment Process (ICAAP) to determine the quantity and quality of capital to conduct

    its business activities. In preparing the ICAAP, the high risk areas established in the Enterprise Risk Management Framework (ERMF) are

    subject to stress testing which incorporates assumptions established in the annual strategic planning process. The results of the stress tests

    help to determine the quantum of capital required to enable management and the Board to set capital levels appropriate with the Bank’s

    RAF.

    The Bank’s CRRMC is responsible for overseeing the types of risk to which the Bank may be exposed and of the techniques and systems used

    to identify, measure, monitor, report on and mitigate those risks. It is also responsible for reviewing capital management plans recommended

    by Management. The Bank’s stress testing program is reviewed with the CRRMC by Management on a quarterly basis and the ICAAP is

    reviewed annually prior to recommendation by the CRRMC to the Board for approval.

    Corporate Governance

    The Bank maintains a rigorous corporate governance structure as follows:

    • Board of Director’s Oversight

    • Conduct Review and Risk Management Committee

    • Audit Committee

    • Corporate Governance and Compensation Committee

    The Bank also has independent oversight functions which include a Chief Risk Officer, a Chief Compliance Officer and a Chief Anti-Money

    Laundering Officer that report directly to the CEO and the CRRMC.

    The Board seeks to achieve long-term sustainable risk adjusted growth in order to ensure the health of the Bank and the stability of earnings

    while protecting the Bank’s well respected brand name and reputation, the interests of its depositors and customers and investors. The Board

    is in support of the Bank increasing new mortgage originations and long-term sustainable portfolio growth with increased profitability and

    improved Return on Equity while managing and maintaining all the associated potential risks with prescribed regulatory limits.

    Business risks

    As a result of the Bank’s business model and the terms and conditions of a reverse mortgage, the most material risks faced by the Bank are as

    listed below:

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    5

    Table 1. Scope of application (continued)

    Underwriting risk

    Provided the homeowner is not in default, the right of the Bank to receive principal and interest when due under the reverse mortgage is

    limited to the realized value of the property. Underwriting risk is the potential for financial loss if the assets as currently reflected on the

    Bank’s balance sheet become impaired and not fully recoverable. In particular, this can result from a significant and persistent drop in real

    estate values and/or customers choosing not to repay their mortgages for an extended period of time. The Bank has developed reverse

    mortgage underwriting criteria which provide reasonable loan to value ratios for the homeowner while seeking to provide assurance that the

    value of the related property upon maturity will be sufficient to repay the reverse mortgage.

    Competition Risk

    The Bank is Canada’s only national underwriter of reverse mortgages, however there are companies in Canada that offer other alternative

    products that may compete with the Bank. It is also possible that at some time in the future, banks, other financial services companies or

    foreign held reverse mortgage providers may decide to enter the market in direct competition to the Bank. The Bank believes that it has

    established a defensible competitive advantage as a result of its low cost funding, proprietary data, internally developed systems and its

    established brand recognition and marketing network.

    Funding and Liquidity Risk

    Funding and liquidity risk can occur as a result of the uncertain timing of reverse mortgage cash flows and the Bank’s reliance on raising funds

    by the issuance of guaranteed investment certificates and medium-term notes. The Bank has a diversified range of funding sources and has

    created policies and procedures to ensure that cash flows are accurately predicted and monitored. It also maintains a sufficient amount of

    liquid assets to fund its anticipated loan commitments, operations, deposit maturities and interest payments should a shortfall arise

    Interest Rate Risk

    The Bank’s operating margin is primarily derived from the spread between interest earned on the mortgage portfolio, and the interest paid

    on the debt and deposits used to fund the portfolio. Risk arises from the Bank’s assets and liabilities having mismatched re-pricing dates,

    being referenced to different underlying instruments or when the long term expectation of the quality of assets diminishes. The Bank has

    adopted hedging practices to maintain a relatively stable spread between interest earned on the mortgages and interest paid on the highly

    rated debt used to fund them.

    Media and Reputation Risk

    Management is aware of the potential negative effects of media and reputation risk exposure. The Bank has implemented complaint and

    incident resolution processes to mitigate these potential risks.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    6

    Table 1. Scope of application (continued)

    Operational Risk

    Operational risk can arise through breakdowns in internal controls and corporate governance, resulting in financial loss. The Bank has

    implemented policies, procedures and internal controls to detect, prevent and manage business activity and to control operational risk.

    Regulatory Risk

    Regulatory risk arises from a financial institution’s non-compliance with applicable laws, rules, regulations and prescribed standards in any

    jurisdiction in which the institution operates. The Bank addresses regulatory requirements in a timely manner to ensure it is compliant with

    new applicable regulations. The Compliance and Risk Management functions keep the Management team and the Board of Directors (the

    Board) informed of new regulations, guidelines and changes to existing regulatory requirements.

    Table 2/3. Capital Structure and Capital Adequacy

    Objectives, policies and processes

    The overall objective of capital management is to ensure that the Bank has sufficient capital to maintain its operations based on current

    activities and expected business developments in the future and to provide a return to its shareholder commensurate with the risk of the

    business and comparable to other, similar companies. The Bank’s capital resources consist of equity and unsecured subordinated debt.

    The Bank’s regulatory capital requirements are specified by OSFI guidelines. These requirements are consistent with the framework of risk

    based capital standards developed by the BCBS and are referred to as Basel III. The Bank adopted certain Basel III capital requirements, as

    required by OSFI, beginning January 1, 2013. The transitional basis allows for the transition of certain capital deductions over a period ending

    January 1, 2018, whereas the all-in basis includes all applicable deductions immediately. Amounts not yet deducted from capital under OSFI’s

    transitional rules are risk weighted, creating a difference between risk-weighted assets on a transitional and on an all-in basis.

    The primary impact at adoption was the deduction from Common Equity Tier 1 capital on an all-in basis of $481 related to intangible assets

    which included bank license costs and software, net of deferred taxes. The remaining regulatory adjustment relates to excess mortgage

    allowances which are applicable to both the all-in and transitional basis.

    The Bank has implemented policies and procedures to monitor compliance with regulatory capital requirements. The Bank has implemented

    an Internal Capital Adequacy Assessment Process which is based on the Bank’s assessment of the business risks of the Bank.

    The Bank’s capital structure, risk-weighted assets and capital ratios, on the all-in and transitional basis are detailed in the tables below:

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    7

    Table 2/3. Capital structure and Capital Adequacy (continued)

    Capital structure

    The Bank’s internal capital consists of Common Equity Tier 1 and Tier 2 capital. Common Equity Tier 1 capital consists of common shares and

    deficit reduced by regulatory adjustments. Tier 2 capital consists of subordinated debt in compliance with OSFI Guideline A requirements for

    Tier 2B limited life instruments. The Bank has authorized an unlimited number of common shares. As at December 31, 2013, the Bank had

    108,683 common shares issued and outstanding.

    (1) Regulatory deductions on the all-in basis include intangible assets related to bank license costs and software, net of deferred taxes, and excess mortgage allowances.

    ALL-IN BASIS

    (in thousands of Canadian dollars)

    Dec 31

    2012

    Mar 31

    2013

    Jun 30

    2013

    Sep 30

    2013

    Dec 31

    2013

    Common shares 129,261 129,261 129,261 129,261 129,261

    Deficit (32,749) (31,665) (30,139) (27,261) (24,821)

    Regulatory adjustments (1) (371) (979) (1,050) (1,096) (1,050)

    Common Equity Tier 1 capital 96,141 96,617 98,072 100,904 103,390

    Book value of unsecured subordinated debt 40,975 30,975 30,975 30,975 30,975

    Less: accumulated amortization for capital adequacy

    purposes

    (12,000) (4,897) (6,000) (6,000) (6,000)

    28,975 26,078 24,975 24,975 24,975

    Regulatory adjustments 3,563 3,681 4,136 3,579 3,648

    Tier 2 capital 32,538 29,759 29,111 28,554 28,623

    Tier 1 capital and Total regulatory capital 128,679 126,376 127,183 129,458 132,013

    TRANSITIONAL BASIS

    (in thousands of Canadian dollars)

    Mar 31

    2013

    Jun 30

    2013

    Sep 30

    2013

    Dec 31

    2013

    All-in Common Equity Tier 1 capital 96,617 98,072 100,904 103,390

    Transitional adjustments 558 539 512 481

    Common Equity Tier 1 capital 97,175 98,611 101,416 103,871

    Tier 2 capital 29,759 29,111 28,554 28,623

    Tier 1 capital and Total regulatory capital 126,934 127,722 129,970 132,494

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    8

    Table 2/3. Capital structure and Capital Adequacy (continued)

    Risk-weighted assets

    The Bank’s risk-weighted assets include all on-balance sheet assets weighted for the risk inherent in each type of asset, an operational risk

    component based on a percentage of average risk-weighted revenues and a market risk component for off-balance sheet derivative financial

    instruments. The Bank uses the standardized approach for credit risk for all on-balance sheet assets, basic indicator approach for operational

    risk and the standardized approach for market risk.

    The Bank’s investment securities may consist of bank debt securities, government and provincial debt securities and corporate debt securities

    with ratings ranging from R1-low to R1-high and their equivalents. The Bank uses DBRS Limited for determining credit ratings. Investment

    securities have risk-weightings ranging from 0% to 50% based on their credit rating. Loans receivable, consisting of residential reverse

    mortgages have a risk-weighting of 35% to 100% with an average risk-weighting of 44.4% at December 31, 2013. All other assets are risk-

    weighted at 100%.

    ALL-IN BASIS Risk-weighted assets

    (in thousands of Canadian dollars)

    Dec 31

    2012

    Mar 31

    2013

    Jun 30

    2013

    Sep 30

    2013

    Dec 31

    2013

    Corporate debt securities 9,098 4,718 3,786 4,595 3,596

    Provincial treasury bills 594

    Deposits with regulated financial institutions 13,918 9,106 7,732 12,408 10,444

    Residential reverse mortgages 583,444 605,027 622,626 647,247 671,333

    Other assets 57,983 57,016 56,828 57,520 57,564

    665,037 675,867 690,972 721,770 742,937 Off-balance sheet exposure 3,703 3,645 2,498 2,482 2,423

    Credit risk 668,740 679,512 693,471 724,252 745,360

    Operational risk (average three-year gross income) 47,031 47,391 48,723 49,894 51,375

    Total risk-weighted assets 715,771 726,903 742,193 774,146 796,735

    TRANSITIONAL BASIS Risk-weighted assets

    (in thousands of Canadian dollars)

    Mar 31

    2013

    Jun 30

    2013

    Sep 30

    2013

    Dec 31

    2013

    Total risk-weighted assets on All-in basis 726,903 742,193 774,146 796,735

    Transitional adjustments 558 539 512 481

    Total risk-weighted assets on Transitional basis 727,461 742,732 774,658 797,216

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    9

    Table 2/3. Capital structure and Capital Adequacy (continued)

    Capital ratios

    ALL-IN BASIS

    Dec 31

    2012

    Mar 31

    2013

    Jun 30

    2013

    Sep 30

    2013

    Dec 31

    2013

    Common Equity Tier 1 ratio (1) n/a 13.3% 13.2% 13.0% 13.0%

    Tier 1 Capital Ratio (2) 13.4% 13.3% 13.2% 13.0% 13.0%

    Total Capital Ratio (3) 18.0% 17.4% 17.1% 16.7% 16.6%

    Assets-to-Capital Multiple (4) 11.9x 12.0x 12.0x 12.8x 12.5x

    (1) The Common Equity Tier 1 Ratio is defined as Common Equity Tier 1 capital divided by total risk-weighted assets.

    (2) The Tier 1 Capital Ratio is defined as Tier 1 capital divided by total risk-weighted assets. (3) The Total Capital Ratio is defined as total regulatory capital divided by total risk-weighted assets. (4) The Assets-to-Capital Multiple is calculated by dividing total assets, including specified off-balance sheet items net of other specified deductions, by

    total capital.

    (1) The Common Equity Tier 1 Ratio is defined as Common Equity Tier 1 capital divided by total risk-weighted assets.

    (2) The Tier 1 Capital Ratio is defined as Tier 1 capital divided by total risk-weighted assets. (3) The Total Capital Ratio is defined as total regulatory capital divided by total risk-weighted assets. (4) The Assets-to-Capital Multiple is calculated by dividing total assets, including specified off-balance sheet items net of other specified deductions, by

    total capital.

    For purposes of meeting minimum regulatory capital ratios prescribed by OSFI, the all-in basis is required. The Assets-to-Capital Multiple

    (ACM) is calculated and evaluated on a transitional basis. During the year ended December 31, 2013 and 2012, the Bank complied with the

    OSFI guideline related to capital ratios and the assets-to-capital multiple. Both the Tier 1 and Total Capital Ratios remain above OSFI’s stated

    minimum capital ratios of 7% and 10%, respectively, for a well-capitalized financial institution. The Bank’s ACM remains below the maximum

    permitted by OSFI.

    TRANSITIONAL BASIS

    March 31

    2013

    June 30

    2013 Sept 30 2013

    Dec 31

    2013

    Common Equity Tier 1 ratio (1) 13.4% 13.3% 13.1% 13.0%

    Tier 1 Capital Ratio (2) 13.4% 13.3% 13.1% 13.0%

    Total Capital Ratio (3) 17.5% 17.2% 16.8% 16.6%

    Assets-to-Capital Multiple (4) 12.0x 12.0x 12.8x 12.5x

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    10

    Table 4/5. Credit risk – general disclosures for all banks

    The Bank performs regular monitoring of its risks, assessments, and related action plans. Senior management and the Board of Directors

    obtain information that allows them to keep informed regarding the effectiveness of their risk management process and activities. The Bank

    has a Conduct Review and Risk Management Committee to assist the Board in fulfilling its responsibilities.

    Credit risk is the potential for financial loss if a borrower or counterparty in a transaction fails to meet its obligations in accordance with

    agreed terms. Credit risk on the Bank’s cash and cash equivalents is mitigated by maintaining cash balances at Schedule I Canadian chartered

    banks.

    Underwriting risk on the mortgage loans is mitigated by following Board-approved underwriting policies. In particular, during the

    underwriting process, every property is appraised by a certified appraiser with particular attention paid to property type, location and days on

    market of each comparative property. The initial appraised value is subsequently discounted, typically by between 5% and 30%. A rate of

    future property appreciation assumed for the life of the mortgage is low in comparison with the Canadian average for the past 20 years. The

    average rate of assumed appreciation used in the initial underwriting of the existing mortgage portfolio is approximately 0.77%. Each

    mortgage originated is limited in maximum dollar amount and loan-to-value ratio in accordance with internal guidelines. The Bank also

    obtains a first charge on the underlying property securing the mortgage. Underwriting risk is mitigated further by the geographic diversity

    and the collateralization of the portfolio.

    Cash resources and securities

    (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Cash and non-interest bearing deposits with banks 40,225 23,891 29,847 49,056 38,732

    Bank securities 29,363 14,892 8,812 12,983 8,986

    Treasury bills issued or guaranteed by Canada 4,981 4,993 3,993 19,991 3,985

    Treasury bills issued or guaranteed by provinces 2,969 2,979 2,988 43,394 2,982

    Other debt securities 45,491 23,592 18,930 16,977 17,982

    123,029 70,347 64,570 142,401 72,667

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    11

    Table 4/5. Credit risk – general disclosures for all banks (continued)

    Residential reverse mortgages

    Geographic region and loan-to-value

    Residential reverse mortgages are lifetime, interest accruing mortgages that are secured by residential real property. Interest income is

    recognized on an accrual basis on all mortgages and is due together with repayment of the principal at the time the property is vacated by

    the homeowner(s). There are no contractual maturity dates for repayment of the mortgages and all mortgages are uninsured.

    The following tables show the composition of the residential reverse mortgage portfolio by geographic region and loan-to-value (LTV) ratio

    range, which measures the outstanding mortgage balance as a percentage of the most recent appraised value of the property. The overall

    weighted average LTV of the portfolio at 37.3% indicates significant equity in the collateral which would mitigate the risk from economic

    downturns.

    Province (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Ontario 485,445 498,226 507,441 524,589 542,439 British Columbia 470,071 481,548 490,210 503,700 517,091

    Alberta 169,437 175,336 180,315 186,450 194,542

    Quebec 133,573 139,514 144,257 152,697 161,184

    Other 76,547 81,237 85,174 89,973 97,999

    1,335,073 1,375,861 1,407,397 1,457,409 1,513,255

    Provincial LTV %

    Dec 31

    2012

    %

    Mar 31

    2013

    %

    Jun 30

    2013

    %

    Sep 30

    2013

    %

    Dec 31

    2013

    %

    Ontario 38.3 38.5 38.5 38.5 38.4 British Columbia 35.7 35.9 36.1 36.4 36.3

    Alberta 37.8 38.4 39.1 39.1 39.3

    Quebec 35.9 36.3 36.3 36.1 35.9

    Other 35.6 35.8 35.7 35.8 35.8

    36.9 37.2 37.3 37.4 37.3

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    12

    Table 4/5. Credit risk – general disclosures for all banks (continued)

    Residential reverse mortgages (continued)

    Loan-to-value (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Less than 30.0% 219,325 221,683 228,107 239,248 242,008 30.1% - 40.0% 358,113 355,653 351,837 355,009 369,803

    40.1% - 50.0% 406,602 425,707 436,114 450,602 475,111

    50.1% - 60.0% 248,370 255,614 265,605 275,768 292,301

    60.1% - 70.0% 73,007 83,652 85,291 89,994 89,519

    Greater than 70.1% 29,656 33,552 40,443 46,788 44,513

    1,335,073 1,375,861 1,407,397 1,457,409 1,513,255

    Overall LTV 36.9% 37.2% 37.3% 37.4% 37.3%

    Impaired loans

    The following table shows residential reverse mortgages with a loan-to-value ratio of greater than 83%, which management considers

    impaired, and the appraised value of those underlying properties:

    (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Mortgage principal plus accrued interest 7,350 7,048 7,671 9,141 10,925

    Individual allowances (660) (758) (895) (1,228) (1,304)

    6,690 6,290 6,776 7,913 9,621

    Appraised value of underlying properties 8,060 7,577 8,164 9,534 11,583

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    13

    Table 4/5. Credit risk – general disclosures for all banks (continued)

    Residential reverse mortgages (continued)

    Allowance for mortgage losses

    The allowance for mortgage losses is maintained at a level that is considered adequate to absorb incurred losses to the mortgage loan

    portfolio. A mortgage allowance is recorded when, in the opinion of management, there is no longer reasonable assurance of the collection

    of the full amount of principal and interest. Mortgage allowances, in an amount that approximates the present value of projected future

    cashflow shortfalls are determined based on mortgage loans outstanding and the most recently adjusted appraised value of the underlying

    properties. The Bank has both individual and collective allowances as described below.

    Individual allowances

    Individual allowances are recorded when, due to identified conditions specific to a particular mortgage, management believes there is no

    longer reasonable assurance of the collection of the full amount of principal and interest.

    Collective allowances

    Collective allowances are provided for losses incurred within the mortgage portfolio but not yet specifically identified and therefore not yet

    captured in the determination of individual allowances. The Bank evaluates and monitors the underwriting performance indicators of

    mortgages as well as changes in the characteristics of the portfolio. These indicators include a review of general real estate conditions and

    trends and their potential impact on the portfolio, the expected occupancy term and interest rates experienced over the life of a mortgage

    compared to initial underwriting assumptions.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    14

    Table 4/5. Credit risk – general disclosures for all banks (continued)

    Residential reverse mortgages (continued)

    Allowance for mortgage losses (continued)

    (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Individual allowances Balance, beginning of year (485) (660) (660) (660) (660)

    Provision for credit losses (699) (167) (319) (687) (990)

    Write-offs 388 36 36 208

    Recoveries 136 69 48 83 138

    Balance, end of year (660) (758) (895) (1,228) (1,304)

    Collective allowances

    Balance, beginning of year (2,969) (3,563) (3,563) (3,563) (3,563)

    Provision for credit losses (594) (118) (573) (16) (85)

    Balance, end of year (3,563) (3,681) (4,136) (3,579) (3,648)

    Total allowances (4,223) (4,439) (5,031) (4,807) (4,952)

    As a % of total mortgages outstanding 0.32% 0.32% 0.36% 0.33% 0.33%

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    15

    TABLE 8. General disclosure for exposures related to counterparty credit risk

    Derivative instruments

    In the normal course of business, the Bank enters into interest rate derivative contracts to manage interest rate risk, following internal

    interest rate risk management policies. Derivative financial instruments are financial contracts that derive their value from underlying

    changes in interest rates or other financial measures.

    Interest rate swaps are contracts in which two counterparties agree to exchange cash flows over a period of time based on rates applied to a

    specified notional principal amount. A typical interest rate swap would require one counterparty to pay interest based on a fixed rate and

    receive interest based on a variable market interest rate determined from time to time with both calculated on a specified notional principal

    amount. No exchange of principal amount takes place at inception.

    Forward rate agreements (FRAs) are contracts that effectively fix a future interest rate for a period of time. A typical FRA provides that, at a

    pre-determined future date, a cash settlement will be made between counterparties based on the difference between a contracted rate and

    a market rate to be determined in the future, calculated on a specified notional principal amount. No exchange of principal amount takes

    place at inception.

    The Bank’s International Swaps and Derivatives Association agreements require a credit support obligation in the form of government issued

    securities under certain circumstances. At December 31, 2013 $1,500, has been pledged as collateral under these agreements.

    Market risk

    Derivative financial instruments have either no or an insignificant market value at inception. Their value changes in response to relevant

    interest rate, foreign exchange rate or credit price changes, such that the previously contracted terms of the derivative transactions have

    become more or less favourable than what can be negotiated under current market conditions for contracts with the same terms and the

    same remaining period to expiry. The potential for derivatives to increase or decrease in value as a result of the foregoing factors is generally

    referred to as market risk. This market risk exposure to earnings is mitigated as the Bank does not hold or use any derivative contracts for

    speculative trading purposes.

    Credit risk

    Credit risk on derivative financial instruments is the risk of a financial loss occurring as a result of a default of a counterparty on its obligation

    to the Bank. Credit risk is limited by dealing only with Schedule I Canadian chartered banks as counterparties. The maximum derivative credit

    exposure to the Bank is the fair value of derivative contracts presented in the summary table below.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    16

    TABLE 8. General disclosure for exposures related to counterparty credit risk (continued)

    (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Derivative financial instrument assets Notional principal 905,000 870,000 743,500 646,500 548,000

    Replacement cost 15,602 15,299 10,275 10,189 9,980

    Credit risk equivalent 18,517 18,227 12,490 12,409 12,117

    Risk-weighted assets 3,703 3,645 2,498 2,482 2,423

    Fair value 15,602 15,299 10,275 10,189 9,980

    Maturity terms

    The following tables summarize the notional principal and fair value by term to maturity of derivative financial instruments outstanding as at

    December 31, 2013. Maturity dates range from January 2014 to September 2018.

    (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Notional principal Derivative assets

    Maturing within 1 year 322,000 284,500 300,500 202,500 120,500

    Maturing in 1 to 3 years 318,000 438,500 433,000 409,000 392,500

    Maturing in 3 to 5 years 265,000 147,000 10,000 35,000 35,000

    905,000 870,000 743,500 646,500 548,000

    Derivative liabilities Maturing within 1 year 69,500 69,500 35,000 195,000 180,000

    Maturing in 1 to 3 years 55,000 86,000

    Maturing in 3 to 5 years 104,000 89,000 241,000 216,000 230,000

    173,500 158,500 276,000 466,000 496,000

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    17

    TABLE 8. General disclosure for exposures related to counterparty credit risk (continued)

    Maturity terms (continued)

    (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Fair value Derivative assets

    Maturing within 1 year 439 626 538 345 227

    Maturing in 1 to 3 years 7,829 13,212 9,728 9,762 9,541

    Maturing in 3 to 5 years 7,334 1,461 9 82 212

    15,602 15,299 10,275 10,189 9,980

    Derivative liabilities Maturing within 1 year 142 42 1 41 60

    Maturing in 1 to 3 years 63 276

    Maturing in 3 to 5 years 434 145 4,156 3,283 2,763

    576 187 4,157 3,387 3,099

    TABLE 12. Operational risk

    Operational risk can arise through breakdowns in internal controls and corporate governance, resulting in financial loss. The Bank has

    implemented policies, procedures and internal controls to detect, prevent and manage business activity and to control operational risk. The

    Bank’s Operational Risk committee is responsible for the oversight of operational risk, with assistance from various internal business groups.

    The Bank uses the basic indicator approach to measure operational risk in its calculation of risk-weighted assets. Operational risk is calculated

    as shown in Table 3 Capital Adequacy.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    18

    TABLE 14. Interest rate risk

    Objectives, policies and processes

    The Bank’s operating margin is primarily derived from the spread between interest earned on the mortgage portfolio and the interest paid on

    the debt and deposits used to fund the portfolio. Mortgages have various interest rate reset terms, ranging from variable to five-year.

    Interest on all of the Bank’s debt is fixed until maturity. The Bank uses derivative contracts to alter the fixed rate on the debt to match the

    rate reset terms of the mortgage portfolio and to mitigate any fluctuations that changes to the underlying benchmark rates may have on its

    operating margin at the time of the mortgage resets. Interest rates on approximately 31% of the mortgage portfolio are based on the

    Government of Canada Treasury-bill and bond rates whereas interest rates on the debt and derivative instruments are based on the Bankers’

    Acceptance rates. Historically, changes in interest rates do not impact each benchmark rate equally, which may result in a variation in spread.

    The Bank’s Management is responsible for monitoring, managing and reporting interest rate risk in accordance with Board-approved RAF. To

    support the RAF, the Bank has developed an Enterprise Risk Management Framework which includes the Board-approved Risk Policies.

    Compliance with various internal limits articulated in the RAF for net interest income and market value sensitivities are periodically reported

    to the Bank’s Conduct Review and Risk Management Committee which has the oversight responsibility for risk governance and practices.

    Exposure to interest rate risk

    The Bank is exposed to interest rate risk as a result of the mismatch, or gap, between the maturity or repricing date of interest sensitive

    assets and liabilities. The following table identifies the Bank’s assets and liabilities which are sensitive to interest rate movements and those

    which are non-interest rate sensitive.

    (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Interest sensitive

    Total assets 1,473,703 1,463,506 1,482,242 1,610,000 1,595,901

    Total liabilities and equity 1,384,053 1,371,751 1,389,914 1,512,676 1,491,518

    Total interest rate sensitivity gap 89,650 91,755 92,328 97,324 104,383

    Non-interest sensitive

    Total assets 46,105 43,350 44,597 45,301 45,431

    Total liabilities and equity 135,755 135,105 136,925 142,625 149,814

    Total interest rate sensitivity gap (89,650) (91,755) (92,328) (97,324) (104,383)

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    19

    TABLE 14. Interest rate risk (continued)

    Interest rate sensitivity

    The following table provides the potential before-tax impact of an immediate and sustained 100 bps increase or decrease in interest rates on

    net income. These sensitivities are hypothetical and should be used with caution.

    (in thousands of Canadian dollars)

    Dec 31

    2012

    $

    Mar 31

    2013

    $

    Jun 30

    2013

    $

    Sep 30

    2013

    $

    Dec 31

    2013

    $

    Before-tax impact on net income of: 100 bps increase in interest rates 175 196 51 51 84

    100 bps decrease in interest rates (175) (196) (51) (51) (84)

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    20

    REMUNERATION

    The Bank’s remuneration policies are consistent with financial services industry practice. Rewards are based on both on business and

    individual specific performance objectives. Oversight of the Bank’s compensation structure is the responsibility of the Compensation

    Committee, which is comprised of three Directors, two of whom are independent. The Compensation Committee meets at least twice

    annually, and met four times in 2013. External compensation advisors are retained by the Compensation Committee as needed.

    The Bank’s compensation structure includes base salary, short-term cash incentives and for executives a long-term incentive plan. Base

    salary for all employees are reviewed annually and as required by market conditions. In addition to their salaries, Bank employees participate

    in a benefits plan that provides certain health care, dental care, life insurance and other benefits. Bank employees also participate in a

    combination Group Registered Savings Plan/Deferred Profit Sharing Plan.

    Executive Management

    The Bank’s executive compensation program is guided by the tenet that a meaningful portion of key management personnel’s pay should be

    based on business results. Pay for performance encourages senior management to make decisions and take actions that are aligned with the

    Bank’s business objectives and shareholders’ interests. The Bank’s executive compensation program for vice-presidents, senior vice-

    presidents and the president and chief executive officer is built on the core principles of balanced compensation and risk, market

    competitiveness and shareholder value creation. Other than executive management, there are no other material risk takers at the Bank.

    A measured approach to compensation is required. Incentives must drive the right behaviours within the Bank’s risk appetite. Incentive

    compensation plans must factor in risk, rewarding results that are achieved only within a defined risk tolerance. In order for the Bank to

    achieve its strategic goals it needs to attract, motivate and retain experienced talent and leadership. Compensation opportunities are to be

    competitive with similarly sized Canadian financial institutions. There must be a strong link between incentive compensation and long-term

    shareholder value creation. Management’s compensation opportunity must be tied to the achievement of objectives that create sustainable

    growth and long-term shareholder value. The salaries are set in reference to the executive’s level of responsibility, competitive market data,

    internal pay relationships and the individual’s proven capabilities. Every year the CEO makes a recommendation to the Compensation

    Committee for each executive’s base salary.

    Prior to November 30, 2012, while the Bank’s parent, HOMEQ was still publicly traded, Directors and executive management participated in

    HOMEQ’s long-term incentive plans (LTIPs) and received shares under various plans. These plans ceased on November 30, 2012, when

    HOMEQ was acquired by Birch Hill Equity Partners Management Inc. and became a privately-held company.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    21

    REMUNERATION (continued)

    Key management personnel and Directors compensation for 2013 and 2012 was comprised of:

    (in thousands of Canadian dollars)

    Number of

    recipients

    2013

    $

    Number of

    recipients

    2012

    $

    Fixed remuneration Cash-based 12 2,206 10 2,060

    Share-based (1) 12 43 10 973

    Severance payments 2 730 Directors’ fees, expenses and share-based (1) 5 254 8 1,805

    3,233 4,838

    Variable remuneration Cash-based 12 789 10 928

    4,022 5,766

    (1) 2012 includes the settlement of LTIPs during the acquisition of HOMEQ by Birch Hill Equity Partners Management Inc., described above.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures December 31, 2013

    22

    Modified Capital Disclosure Template

    The following summarizes the Bank’s interim transitional and all-in capital Basel III Pillar 3 disclosures as at

    December 31, 2013:

    Modified Capital Disclosure Template(in thousands of Canadian dollars)

    ALL-IN

    BASIS

    TRANISTIONAL

    BASIS

    Common Equity Tier 1 capital: instruments and reserves

    1 Directly issued qualifying common share capital (and equivalent for non-joint stock

    companies) plus related stock surplus 129,261

    2 Retained earnings (24,821)

    3 Accumulated other comprehensive income (and other reserves)

    4 Directly issued capital subject to phase out from CET1 (only applicable to non-joint

    stock companies)

    5 Common share capital issued by subsidiaries and held by third parties (amount

    allowed in group CET1)

    6 Common Equity Tier 1 capital before regulatory adjustments 104,440

    Common Equity Tier 1 capital: regulatory adjustments 28 Total regulatory adjustments to Common Equity Tier 1 1,050

    29 Common Equity Tier 1 capital (CET1) 103,390 103,871

    Additional Tier 1 capital: instruments

    30 Directly issued qualifying Additional Tier 1 instruments plus related stock surplus

    31 of which: classified as equity under applicable acconting standards

    32 of which: classified as liabilities under applicable acconting standards

    33 Directly issued capital instruments subject to phase out from Additional Tier 1

    34 Additional Tier 1 instruments (and CET1 instruments not included in row 5) issued

    by subsidiaries and held by third parties (amount allowed in group AT1)

    35 of which: instruments issued by subsidiaries subject to phase out

    36 Additional Tier 1 capital before regulatory adjustments

    Additional Tier 1 capital: regulatory adjustments

    43 Total regulatory adjustments to Additional Tier 1 capital

    44 Additional Tier 1 capital (AT1) 45 Tier 1 capital (T1 = CET1 + AT1) 103,390 103,871

    Tier 2 capital: instruments and allowances

    46 Directly issued qualifying Tier 2 instruments plus related stock surplus 24,975

    47 Directly issued capital instruments subject to phase out from Tier 2

    48 Tier 2 instruments (and CET1 and AT1 instruments not included in rows 5 or 34)

    issued by subsidiaries and held by third parties (amount allowed in group Tier 2)

    49 of which: instruments issued by subsidiaries subject to phase out

    50 Collective allowances 3,648

    51 Tier 2 capital before regulatory adjustments 28,623

    Tier 2 capital: regulatory adjustments

    57 Total regulatory adjustments to Tier 2 capital

    58 Tier 2 capital (T2) 28,623 59 Total capital (TC = T1 + T2) 132,013 132,494

    60 Total risk weighted assets 796,735 797,216

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013

    23

    Capital ratios

    61 Common Equity Tier 1 (as a percentage of risk weighted assets) 13.0% 13.0%

    62 Tier 1 (as a percentage of risk weighted assets) 13.0% 13.0%

    636 Total capital (as a percentage of risk weighted assets) 16.6% 16.6%

    OSFI all-in target

    69 Common Equity Tier 1 capital all-in target ratio

    70 Tier 1 capital all-in target ratio

    71 Total capital all-in target ratio

    Capital instruments subject to phase-out arrangements

    (only applicable between 1 Jan 2013 and 1 Jan 2022)

    80 Current cap on CET1 instruments subject to phase out arrangements

    81 Amount excluded from CET1 due to cap (excess over cap after redemptions and

    maturities)

    82 Current cap on AT1 instruments subject to phase out arrangements

    83 Amount excluded from AT1 due to cap (excess over cap after redemptions and

    maturities)

    84 Current cap on T2 instruments subject to phase out arrangements

    85 Amount excluded from T2 due to cap (excess over cap after redemptions and

    maturities)